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Interview: Why ICOs became so enticing (and risky) for startups and investors

Initial coin offerings (ICOs) opened up a new front in the cryptocurrency world for startups, investors, and regulators alike. But to a large extent ICOs are still in a Wild West-like era fueled by investor exuberance and little regulatory oversight. This is why Orange Silicon Valley will host an event on February 21 to explore the history and future ICOs. (See our official ICOnomics event page for more information about programming and registration.)

500 Startups Venture Partner Rob Neivert watches ICOs closely and sat down with the OSV blog ahead of our ICO event to discuss his observations. As an experienced executive and investor he has seen blockchain and cryptocurrency interest arrive in the tech world. He spoke with us about some of the concerns that have emerged, as well as the opportunities.

In the first part of our interview with Neivert, he got into the history ICOs, types of companies that have been attracted to them, and what the regulatory environment (or lack thereof) means for investors.

Orange Silicon Valley: At what point did ICOs show up on your personal radar? Do you remember any one moment or event that initially captured your attention?

Rob Neivert: It actually grew out of a couple of previous concepts. Many years ago we actually funded a bunch of companies in the crypto/blockchain space. And a lot of them were saying, “Look how do we create virtual companies? How do we pay people for contributing? We don’t want to form a company to own the code. We want to form this sort of distributed thing — like Linux — where everybody contributes. But how do we pay them?” And that actually formed the foundation of, “Well, let’s create this idea. Back then they didn’t call it this. But what today we would call ‘the coin.’”

They said, “Let’s create a coin, and as people contribute they get paid in these coins.” And then it came down to, well, the current systems just aren’t designed for this. There just isn’t a way to do it. I can’t pay him in dollars. It just doesn’t make any sense. So, jokingly I believe — and I’m certain people don’t agree — it sort of came out of the idea that games like World of Warcraft have gold, so let’s create that same concept. And I think that evolved into coin and ICOs evolved from that because it’s a way of saying, “We want to crowdfund a project.” It’s just like Kickstarter or the rest, but done on the crypto side.

For a long time it was very much restricted to a handful of people — you know, the hardcore developer community and the Silk Road, the sort of edge people, or what I call the engineers who felt this idea of companies owning your data was offensive. That crowd really was there for quite some time. It’s been several years that it’s been fairly active. But it didn’t get a lot of value. There was some basic pre-ICO stuff and a few other things that raised a little bit.

Then there were a couple of tens of millions of dollars instances, some funds and a few others that got started — and that sort of created a little bit of prep for it. But I think what really moved it was that when crypto suddenly came up in value, you had a huge number of people with house money — that is, they put in $1,000, and now they’re worth $100,000. They’re willing to gamble the $99,000 now. People’s behaviors change. They took much more risk and threw bigger and bigger money at things, because it was all house money; it was all money they hadn’t taken from anything.

And that’s where you saw huge numbers of raises with all these miners that had a huge amount of crypto and didn’t really want to convert it. So what do you do with it? There’s no way to invest it. So that was their stock market.

ICOs have become the thing where you invest money after you’ve made it and you don’t want to convert it back to currency. It became the outlet, the way to invest in the crypto world. There is generally $60-70 million a day created through mining. I mean, Ripple was effectively zero a few years back. All of that’s new money.

So a large chunk of it is simply — and this is what bothers a lot of old Wall Street people is — poof, it suddenly comes into valuation and seemingly has no basis. If you think about it the USD has value only because we believe it does. If people are willing to exchange goods and services it has value. Same with crypto. You don’t need a government to support it, if the community does.

OSV: I’m glad you brought that up. It’s a really good point. To follow up on what you said earlier about the Kickstarter parallels, what types of business models do you see benefiting from the ICO approach?

RN: I’ve started seeing hundreds and hundreds of blockchain companies, and many of them make no sense at all.

But there are a lot of cases. I’m going to give you maybe two or three really key examples; crypto really works well, especially for international transactions or currencies where you’re crossing a lot of borders. And where, honestly, the banking system is extremely difficult if you’re shipping international goods.

It literally stuns people how painful it is to move money around internationally, even if I own divisions in multiple countries. It’s just painful. That’s one. If you’re moving within the United States, yeah, it’s a pain, but it’s not terrible. But internationally it’s really quite, quite, quite painful.

The second scenario is anywhere where there’s volatile currencies, where people don’t trust the government. We forget here in the U.S. But if you go to Argentina or the Middle East, people don’t want to store their wealth and their money in the currency. It could be valueless in a week.

So international commerce. Storage of wealth outside of a country when you don’t trust the country. Those are two. Blockchain is phenomenally useful for international commerce where you can pay on the blockchain. The commerce transactions of moving goods from one to the other, and I need to be able to validate whether it was delivered, and what was delivered, and what was paid, is incredibly complicated. And there’s a huge amount of pain involved in getting that stuff resolved.

Blockchain or general [distributed ledgers] — even if it’s IBM Hyperledger — they solve a tremendous amount of problems. So commerce or interaction between multiple companies where people are not trusted, especially internationally is the key here.

OSV: In addition to concerns inside startups, what are the questions that investors are asking as they put money into companies holding ICOs?

RN: Let’s start off with two quick ones. There are multiple ICOs a day at this point. It has become massive as far as volume. A large number of them are junk — complete junk. The white papers are poorly written; there’s no real team. There is an enormous amount of false information. I seriously warn people about this; it’s incredibly important to understand there is no SEC here. There are people posting white papers that are absolutely, blatantly false. They’re absolute lies. There is nothing to say they can’t do that. There’s no law, there’s no accounting. You can’t sue them. You can’t take them to court. They don’t even know what country they are in. Several of the largest exchanges are unknown owners; you don’t know what country they’re in.

So understand the first thing: This is not unique. You need to be very careful about what is validated, what’s truth here and what’s just made up and what’s manipulated, Ponzi schemes and other things like that. So that’s my first statement.

Does that make sense?

OSV: Absolutely. I think it gets to the point that many of these are companies that haven’t gone through a traditional process of regulatory checks.

RN: Let’s assume I personally have a thing called “gamble money,” which is the amount of money where I don’t care if it goes up, down, whatever, I know it doesn’t bother me. I’ll read a white paper I find interesting, I’ll research the founders, make sure they’re real. I’ll do a bit more research to make sure it’s a real thing. I want to check out some of the basic structure to make sure there’s something. And honestly I do check to see if they’re in a country that has some law. Switzerland is a very common one now — Zug, Switzerland or Singapore or the United States. So a little bit of that, and I’m willing to throw a little gamble money at it. But I’ve been tricked more than once.

So my statement to most people is you need to think about it just like gambling. You can’t think about this like investing. Not yet. There is no external validation entity, and until that exists — the equivalent of the SEC and contract law and courts and legal systems — you need to see this as gambling. And as long as you’re okay with that concept, this is OK.

There are very few ICOs where there really is a lot of authority behind them. There are a few; they register with the SEC as a security. They’re being completely aboveboard; they’ve got auditors; they’ve got outside agencies; they’re based in New York. For them, that’s different. That’s actually an investment. You can do that one. I think that’s probably the most secure, where they’ve declared to the SEC that it is a security, they are selling it as a security; it’s gone through all the right procedures there. They have all the right authorizations, and they have an external entity including an auditor that’s saying it’s a true thing. Yeah, you could still get ripped off like you can get ripped off on stocks. But at least there’s something there. There’s some risk that’s gone away.

Editor’s note:Continue to part 2 of our interview with Rob Neivert, where he discusses the regulatory issues that ICOs will face.

Orange Silicon Valley and the National Venture Capital Association will explore the topic of policy and regulation, as well as the future of ICOs and cryptocurrency at a February 21 event in San Francisco. Speakers include regulators, lawyers, entrepreneurs and investors who are actively involved in the ecosystem. The special guest speaker is Joseph Borg, Director of the Alabama Securities Commission and President of the National American Securities Administrators Association. Smart Money magazine listed Borg in its listing of “The Power 30- The Top Financial Players” citing his 98% conviction rate and calling him “one of the toughest ‘stock cops’ in America.” Please join us for this discussion by registering for the ICOnomics event here.

Disclaimer: The views and opinions expressed in this article belong to the author and do not necessarily reflect the position or views of Orange or Orange Silicon Valley.

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Orange Silicon Valley (OSV) is the San Francisco Bay Area presence of Orange, one of the world’s leading telecommunications operators. We actively engage with San Francisco and Silicon Valley, and participate in the disruptive innovations changing the way we communicate.